Wednesday, 10 October 2012

Does it matter if my broker holds the title to my shares?

In my previous post on Interactive Brokers, I mentioned the fact that they act as custodian over my shares and that I would do a post on the upsides and downsides of holding the shares in the name of interactive brokers instead of your own.

What is the difference between holding the title to shares yourself and the broker holding title

There are several practical and legal differences in the way that shares are held.  I shall outline only a few below.  It is probably worth researching further and seeing how different brokers operate before making the decision about whether you are comfortable with it.

Practical differences in the way title is held

  • When title is held in your name the company knows that you are an investor.  When it is held through a custodian all they know is that a custodian has customers with x number of shares.  Thus all communications are with you instead of with the custodian.  You will notice that when you go through a custodian that you never receive any correspondence yourself and dividends are paid to your custodian not to your bank account.
  • The rights to participate in things such as DRP's and corporate actions are at the discretion of the custodian if they are held in their name.  This is why Interactive Brokers does not allow DRP's however it does have a system for corporate actions.  The same applies for voting.
Legal implications regarding the way shares are held
  • Custodians should hold your shares in a trust outside the business structure.  They do not own your shares and only hold them for you on trust.  However there have been examples, most recently in the GFC, of customers losing their money due to dodgy practices - see the example below
  • If your custodian is based in the US you may not be able to participate in some corporate actions.  Due to how strict the SEC is on filing requirements, a lot of companies specifically exclude US investors from participating in equity raisings and corporate actions.  You need to make sure that you are not affected by this.  Interactive Brokers tends to set up entities in various regions so it has not been a problem for me to date.

What can go wrong - A Prime Example

The collapse of many independent brokers during the GFC really brought to light the issues that can occur when you do not hold the title to your shares in your own name.  In Australia the primary example was Opes Prime, an Australian share broker which held the shares in the companies name rather than the individual investor.

When Opes collapsed in 2008 the customers expected (rightly) that their shares could simply be transferred to another broker. Instead Opes had, illegally, borrowed against these shares for their securities lending business and the lender to this business called in that collateral, sold the shares at a significant loss and the customers of the business only got back a fraction of what was rightfully theirs.

Let us be very clear from the start - what Opes did was illegal.  There should have been a trust outside the main Opes entity to hold the shares of customers as the company had no right to treat these shares as their own assets.  The customers could sue the company afterwards, however if the company is bankrupt there is little point in suing them.

What should you do IF your broker holds your shares in their name (like Interactive Brokers)

If you acknowledge the risks of investing through a broker which does not hold the shares in your name and still decide to go ahead with it (because of their low costs of trades or access to more international markets etc.) then you need to put in place risk mitigators.

You need to keep a constant look out for signs of financial stress at your broker.  You owe them no loyalty.  At the first sign that they might be in trouble it is time to abandon ship and transfer your shares to another broker (I suggest having another brokerage account) where shares are held in your name.

Set up news alerts and ALWAYS read their disclosure statements (even though it may be particularly boring).  It is not worth losing all your investment portfolio (which presumably you worked your whole life for) because you have been lazy.

You May Also Be Interested In:
Interactive Brokers - All topics
Interactive Brokers - The negatives start to pile up
Corporate Actions on Interactive Brokers
Interactive Brokers - No DRP


  1. This comment has been removed by a blog administrator.

    1. Hi Clement...really any broker that gives you title to the shares works just as well as another for this reason. If risk mitigation was your strategy, in addition to finding a broker that holds the shares in your name, I would go for a large institution or bank that is never going to go bust.